5 Steps to Create Your Retirement Paycheck
March 24, 2015 | Your Finances
Retiring on a generous pension or living solely on Social Security is a way of life that largely disappeared along with pay phones and cassette tapes. These days, a major portion of your retirement paycheck will come from money you’ve stashed away yourself. Here are five things to consider when accumulating your savings and preparing for eventually spending that money during retirement.
1. Start early. Creating a retirement paycheck starts long before retirement. It isn’t always the first thing on your mind when you begin your career or start a family, but the sooner you start a regular savings program, the better your long-term results will be.
“Smaller sooner beats larger later,” says Ross Junge, MBA, CFA®, director of investment services at McGill Junge Financial in Des Moines, Iowa. “It’s a simple strategy of being disciplined and systematic. The younger you start, the less it takes each month to create the amount of wealth you need to create reliable income for retirement.”
Junge’s partner, Northwestern Mutual Wealth Management Advisor Ed McGill, CFP®, RICP®, recommends using an automatic payroll deduction plan that helps make saving painless. “Set aside a certain amount to be taken out of your paycheck before you even see it, and don’t forget to save dollars outside of your company’s retirement plan for greater diversification.”
2. Make the most of your prime earning years. Your 50s and early 60s are likely the highest-earning years of your career. This is the time to make sure the foundation of your retirement savings is solid so you’re ready to move from saving to spending.
Junge calls the 10 years right before retirement the “accelerated years of saving.” For many, the kids are out of college and out of the house, the mortgage is close to being paid off, and the budget opens up with more disposable income available for saving. “At this point, you’ll want to close any gaps in your retirement plan and build in additional flexibility.”
Building in a cushion is particularly critical in the event you aren’t able to work as long as you’d like because of either a health issue or downsizing at your workplace.
“Fine-tune your plan to determine how much is needed specifically for essential needs—such as tax payments and food budget—versus the discretionary dollars for travel, going out to eat or hobbies,” says Junge. A financial professional can stress-test different retirement scenarios and recommend adjustments to your savings plan, if necessary.
3. Diversify your income sources. You may be familiar with the concept of diversification within your investment portfolio, but how do you diversify your income sources to provide a stable base of guaranteed retirement income while allowing for growth?
Your retirement income sources may be fixed (pensions, Social Security and annuities) or variable (investments, 401(k)s, traditional and Roth IRAs). The value of variable retirement savings—and your income from those sources—can fluctuate with market volatility. The more options you have for retirement income sources, the more protection you have from market dips.
In particular, ensuring that you have a portion of your retirement income guaranteed with pensions or income annuities allows you more flexibility to leave your investment accounts untouched following a market correction until the market has a chance to rebound.
4. Consider taxes. An old rule of thumb was to invest pretax dollars as much as possible and defer taxes until retirement, when you’d be in a lower tax bracket. But if you’ve saved dutifully so you can replicate your current lifestyle in retirement, you might not be in a lower tax bracket at all. To maximize your retirement income, make sure your plan is built for tax efficiency.
“As much as you hate paying taxes now, you’ll hate it a whole lot more in retirement. It’s just as important to win the tax game from age 60 to 100 than today,” warns McGill.
Be more strategic about reducing your future tax bill. If you put everything in a pretax 401(k), for example, all of your assets will be taxable during retirement.
“A Roth IRA can be a very attractive as an after-tax investment account. Or strongly consider forgoing the current tax deduction and invest in a Roth 401(k), which is becoming much more common.” If your income exceeds the federal limits for investing in a Roth IRA, talk to your financial professional about other strategies that will reduce your taxable income in retirement.
With different “buckets” to choose from, your financial professional can practice “bracket management” during retirement—that is, strategizing where and when to withdraw funds from various accounts to minimize taxes while maintaining the retirement lifestyle you want.
5. Don’t set it and forget it. “After age 50, it’s a good idea to update your plan every year to ensure that your glide path to retirement is progressing as intended,” says Junge. In the years prior to retirement and during retirement, variables such as changes in tax law, health care and insurance costs, children or grandchildren who need financial help, or downsizing in a volatile real estate market can all impact your retirement income. It’s important to review your plan with your financial team—your financial professional, CPA and estate planning attorney—to make sure it still makes sense in terms of those variables.
A financial professional should work through the “what-if” scenarios to create a plan with built-in contingencies. “Reviewing the plan once a year to make necessary adjustments can help you enjoy better outcomes no matter what’s happening in the market or with other variables,” McGill says.
McGill has one final piece of advice for people preparing for retirement: “Research has shown that people who have a financial plan that incorporates guaranteed streams of income in retirement have a higher level of enjoyment during retirement.”
In other words, do your planning now to lay the foundation for a happy retirement later.